Hospitals and health systems won't be able to lease equipment or property with contracts that keep such obligations off the balance sheet under a proposed change to accounting rules expected within months.
Putting it on the books
Proposed rules wouldn't allow hospitals to keep leases off balance sheets
The proposal, under development by the Financial Accounting Standards Board since 2006, would get rid of accounting rules that do not consider operating leases as debt, and therefore do not require such contracts to be reported on the balance sheet. The accounting body is expected to release a draft of the rules by the end of September, and new standards would be final by the end of June 2011.
Operating leases are widely used in healthcare as off-balance-sheet financing for photocopiers, telephones and other technology as well as medical office buildings, and the proposed rules would increase reported debt and weaken key measures of leverage.
Credit ratings won't change as a result, analysts said, because agencies already factor operating leases into calculations of healthcare borrowers' financial strength.
But it may put hospitals and health systems afoul of covenants with banks or bondholders, according to accounting and finance experts. How much off-balance-sheet financing hospitals and health systems hold is unclear, they said.
Some health systems have moved to catalog operating leases ahead of the proposals to find out how the contracts will affect balance sheets.
“I don't imagine it would be insignificant for anybody,” said Jenny Barnett, executive vice president of finance for Catholic Health East, which owns 23 hospitals in nine states.
The system launched an inventory of its off-balance-sheet leases last month after finance executives met with auditors in late May for an overview of the proposed accounting change, Barnett said.
The Newtown Square, Pa.-based system reported roughly $279 million in expected operating lease payments in the footnotes of 2009 financial statements, where they must be reported under current accounting rules.
But Barnett cautioned the figure was a “starting point” and said until efforts to catalog the leases are complete, she cannot be certain of how much off-balance-sheet liability the system holds.
Executives are pushing to wrap up the inventory by July 31, ahead of yearly strategic planning meetings, when officials also consider the coming year's capital budgets.
Catholic Health East had previously factored the off-balance-sheet leases into its overall leverage, but the system will evaluate whether new operating lease debt on the balance sheet will change the system's borrowing capacity.
Barnett said the change also raises questions about the use of leases in the future. Operating leases gave hospitals a financing option that did not tie up capital and could be frequently renegotiated, she said.
Barnett said the system won't violate any lending covenants, based on the 2009 reported lease expense.
Those that have not begun an inventory should do so and review debt covenants for potential violations, a potentially significant undertaking depending on how many leases an organization holds, accounting consultants say.
“It's not complicated; it's tedious,” said Robert Valletta, head of U.S. healthcare providers for consultant Pricewaterhouse-Coopers.
Accounting and credit experts said the new rules seek to improve disclosure and address criticism that old rules could be manipulated so that leases could be moved off the balance sheet.
“We think this is part of the move for greater transparency,” said Lisa Goldstein, senior vice president and healthcare team leader for Moody's Investors Service.
Eddie Marmouget, a partner with accounting consultants BKD, said the proposal follows other recent accounting shifts to improve financial reporting and is part of an effort to reconcile U.S. and international accounting standards.
According to Oliver Jurkovic, a partner with accounting consultants Plante & Moran, the new rules will also eliminate incentives to structure lease terms solely to keep debt off the balance sheet.
Jeff Schaub, a managing director with Fitch Ratings, said that any changes to financing strategies as a result of the new rules would be considered during ratings reviews.
“We don't expect to see many cases where changes would materially affect credit ratings,” Schaub said. The change could also prompt Fitch to adjust thresholds for financial measures used to determine ratings categories, he said.
Schaub said he expects that lenders will waive violations if healthcare borrowers violate debt covenants as a result of the accounting change.
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